The ‘Risk-Free’ Crypto Trade Is Back In a Big Way

By Vildana Hajric and Katherine Greifeld
October 18, 2021, 3:16 PM EDT

The closest thing to a risk-free bet has reemerged in the cryptocurrency market as traders — awaiting the launch of the first Bitcoin exchange-traded fund — bid up the price of futures.

The spread between Bitcoin futures and the digital currency’s price offers the widest annualized return in five months, according to data from FRNT Financial. That means the so-called basis trade, whereby a speculator buys Bitcoin in the spot market and sells long-dated futures to lock in the discrepancy between the two prices, has turned back on. And it’s happening amid a price surge in Bitcoin that’s been bolstered by optimism the Securities and Exchange Commission is poised to allow the first U.S. Bitcoin futures ETF to begin trading soon.
It’s a dynamic that comes back again and again in crypto and is one that is rarely seen in other markets, according to Strahinja Savic, head of data and analytics at FRNT Financial. It’s primarily driven by individual investors, who are using futures for leverage and to make price predictions.

“Crypto is unique in that it has a much higher retail participation versus sophisticated institutional actors, who would normally drive down the exaggerated contango via arbs trades,” said Savic, referring to arbitrage. “Considering the lack of those actors’ participation, relative to other assets, BTC is prone to these aggressive contangos in bull markets — we find this kind of an opportunity to be an extremely underrated and lucrative strategy in crypto.”

Futures typically trade at a premium to spot, a development referred to as contango. Contango and backwardation are terms for curve structures that map traders’ guesses about what a given contract could be worth in the future. Contango means it’s upward sloping, while backwardation means downward.

Futures in contango indicates that the supply of Bitcoin is plentiful because there is no cap on futures open interest, says Steve Sosnick, chief strategist at Interactive Brokers. As long as enough traders post sufficient margin with a clearinghouse, any two counterparties can create a new futures contract by initiating a trade, he said. Right now, a lot of traders might be betting that a futures-based ETF will be a big forced buyer in the market. Whatever money ends up flowing into the product will have to be employed to buy futures contracts, the thinking goes.
“There is a well-hyped new asset class that has to contractually buy these futures, and traders are adjusting and front-running accordingly,” he said. “It’s quite possible that the market got ahead of itself, which is certainly a risk in the crypto space, but there is clearly a bet being placed that fresh money will be coming into crypto via the futures ETFs.”

To be sure, more traders could look to take advantage of the spread, meaning that it could shrink, says Zhu Su from Three Arrows Capital, a hedge fund.

“You’ll have a lot of capital come in to arbitrage because it’ll get to the point where it’s very attractive. If you can get 6%, 10% on dollars there’s a lot of guys that will want to do that,” said the firm’s co-founder. “It just takes one bank or one participant with a few billion dollars to come in. If you zoom out, it’s not going to be that bad.”

Though it had broken down earlier in the year amid a selloff in crypto prices, the basis trad has been one of the most pervasive in the crypto industry. It’s been known to be widely used by hedge funds thanks to its ability to reliably produce double-digit annual gains.

“The future price is up higher than the spot market and this is where we see a lot of arbitrage plays from the big boys,” Howard Greenberg, president of the American Blockchain and Cryptocurrency Association in D.C. and cryptocurrency educator at Prosper Trading Academy, said by phone. “They’ll play that spread — they’ll buy the underlying asset at a less expensive price and then bid up the futures, and they’ll sell-off into the strength of the market.”